Are All Security Analysts Equal?

We examine the extent to which security analysts are homogeneous in their effect on firm valuation as measured by Tobin's Q. Earlier research documents a significant and positive relation between analyst coverage and firm valuation. We identify three classes of equity analysts and examine their differential effect on firm valuation associated with their coverage and their information production. We find that equity analysts are not homogeneous in their effect on firm valuation. The presence of analysts at national securities firms have the strongest effect on firm valuation followed by analysts at regional securities firms and finally analysts at nonbrokerage, or research, firms. We attribute this result to the differential monitoring and information dissemination function rendered by the analysts. Information produced by analysts, however, does not share the same credibility. Specifically, we find brokerage firms' buy recommendations are discounted by the market and have a weak effect on firm valuation. The results can be supported by arguments that brokerage firm analysts' recommendations are contaminated by their firms' investment banking relations with corporations.     

Do investment banks listen to their own analysts?

To what extent conflicts of interest affect the investment value of sell-side analyst research is an ongoing debate. We approach this issue from a new direction by investigating how asset-management divisions of investment banks use stock recommendations issued by their own analysts. Based on holdings changes around initiations, upgrades, and downgrades from 1993 to 2003, we find that these bank-affiliated investors follow recommendations from sell-side analysts in general, increasing (decreasing) their relative holdings following positive (negative) recommendations. More importantly, these investors respond more strongly to recommendations issued by their own analysts than to those issued by analysts affiliated with other banks, especially for recommendations on small and low-analyst-coverage firms. Thus, we find that investment banks “eat their own cooking,” showing that these presumably sophisticated institutional investors view sell-side recommendations as having investment value, particularly when the recommendations come from their own analysts.     

Trade Generation, Reputation, and Sell-Side Analysts

This paper examines the trade‐generation and reputation‐building incentives facing sell‐side analysts. Using a unique data set I demonstrate that optimistic analysts generate more trade for their brokerage firms, as do high reputation analysts. I also find that accurate analysts generate higher reputations. The analyst therefore faces a conflict between telling the truth to build her reputation versus misleading investors via optimistic forecasts to generate short‐term increases in trading commissions. In equilibrium I show forecast optimism can exist, even when investment‐banking affiliations are removed. The conclusions may have important policy implications given recent changes in the institutional structure of the brokerage industry.     

Whose money is smart? Individual and institutional investors’ trades based on analyst recommendations

This study explores how institutional and individual investors respond to analyst recommendations. Using a unique account-level trading dataset taken from the Shanghai Stock Exchange, we obtain direct evidence to show that (1) active institutional investors are significantly net buyers (net sellers) on “strong buy” and “buy” (“hold” and “sell”) recommendations; (2) active institutional investors condition their trades based on the buy-side pressure of analysts; (3) institutional investors earn abnormal returns by incorporating analysts’ buy-side pressure into their trading reactions to analyst recommendations; and (4) individual investors, in contrast, exhibit abnormal trade reactions opposite to those of active institutional investors. Our results are robust to alternative measures and different specifications. This study provides evidence that active institutional investors are more sophisticated processors of information and provides support for regulators’ concerns about the sub-optimal investment decisions made by individual investors who are unaware of the potential conflicts of interest analysts may face.     

Firm-specific information,analysts' superiority and investment value

Using a sample of Chinese security analysts’recommendations from 2005 to2010,we examine the source of analysts’superiority and the investment value of their recommendations.Using a calendar-time portfolio approach,we find that,on average,analysts’recommendations are valuable and that analysts are better at analyzing and transferring firm-specific information than market-wide or industry-level information.In addition,we show that the investment value of recommendations increases as firm-specific information becomes more important in stock pricing.Our empirical results are useful in guiding investors and helping brokerage houses to evaluate the output of research departments.     

监督抑或跟随：机构投资者治理角色研究——来自舞弊公司机构持股行为的经验证据

文章利用被中国证券监管部门处罚的舞弊公司及未舞弊公司为对象,考察机构投资者在公司治理中是扮演监督者还是跟随者角色。研究发现,从公司舞弊前一季度到后一季度机构投资者并未减持舞弊公司股份,不具备舞弊预测与识别能力;机构投资者倾向于利用分析师评级结果进行投资决策;机构投资者容易被舞弊公司误导,而分析师评级则有助于减轻机构投资者被误导程度。结果表明,目前机构投资者更多扮演着跟随分析师的消极角色而非有效监督者的积极角色,分析师评级具有一定的决策有用性。     

Which types of analyst firms are more optimistic?

Research optimism among securities analysts has been attributed to incentives provided by underwriting activities. We examine how analysts’ forecast and recommendation optimism varies with the business activities used to fund research. We find that analysts at firms that funded research through underwriting and trading activities actually made less optimistic forecasts and recommendations than those at brokerage houses, who performed no underwriting. Optimism was particularly low for bulge underwriter firm analysts, implying that firm reputation reduces research optimism. There is also evidence that analysts at retail brokerage firms are more optimistic than those serving only institutional investors. We conclude that analyst optimism is at least partially driven by trading incentives.     

The impact of all-star analyst job changes on their coverage choices and investment banking deal flow

Using a sample of all-star analysts who switch investment banks, we examine (1) whether analyst behavior is influenced by banking relationships and (2) whether analyst behavior affects investment banking deal flow. Although the stock coverage decision depends on the relationship with the client firms, we find no evidence that analysts change their optimism or recommendation levels when joining a new firm. Investment banking deal flow is related to analyst reputation only for equity transactions. For debt and M&A transactions, analyst reputation does not matter. There is no evidence that issuing optimistic earnings forecasts or recommendations affects investment banking deal flow.     

Underwriting Relationships and Analyst Independence in Europe

This paper examines the accuracy of security analysts’ earnings forecasts and stock recommendations for firms in 13 European countries. We document at least three key findings. First, we find strong evidence that lead and co‐lead underwriter analysts’ earnings estimates and stock recommendations are significantly more optimistic than those provided by unaffiliated analysts. Second, we find that lead and co‐lead underwriter analysts’ earnings forecast and stock recommendations are significantly more optimistic for underwriter stocks than for those they provide for other stocks. Third, we also find evidence that these biases found within earnings forecasts and stock recommendations are not driven by one particular country. In short, these findings suggest that affiliated analysts are more optimistic perhaps to maintain investment banking relations.     

Friends can help: The effects of relationship in the Chinese book-building process

Using detailed bidding information in Chinese IPO book-building process, we find that institutional investors who have a close relationship with the underwriter are more likely to participate in bidding and their bidding prices are higher, compared to other institutional investors. We also find that related institutional investors bid higher when the underwriter is more likely to need or receive their support. Further analysis suggests that related institutional investors gain some benefits for their support to the underwriter, including receiving more shares in profitable IPOs, better timing their exit from the IPO in the open market, and receiving more optimistic earnings forecasts or stock recommendations from analysts of the underwriter. Regarding the economic consequence, we show that the underwriter is more likely to revise the offer price upward if related institutions bid higher. The evidence overall indicates the existence of relationship-driven bidding in the Chinese book-building process.     

Inside the “Black Box” of Sell‐Side Financial Analysts

Our objective is to penetrate the “black box” of sell‐side financial analysts by providing new insights into the inputs analysts use and the incentives they face. We survey 365 analysts and conduct 18 follow‐up interviews covering a wide range of topics, including the inputs to analysts’ earnings forecasts and stock recommendations, the value of their industry knowledge, the determinants of their compensation, the career benefits of Institutional Investor All‐Star status, and the factors they consider indicative of high‐quality earnings. One important finding is that private communication with management is a more useful input to analysts’ earnings forecasts and stock recommendations than their own primary research, recent earnings performance, and recent 10‐K and 10‐Q reports. Another notable finding is that issuing earnings forecasts and stock recommendations that are well below the consensus often leads to an increase in analysts’ credibility with their investing clients. We conduct cross‐sectional analyses that highlight the impact of analyst and brokerage characteristics on analysts’ inputs and incentives. Our findings are relevant to investors, managers, analysts, and academic researchers.     

The Client Is King: Do Mutual Fund Relationships Bias Analyst Recommendations?

This paper investigates whether the business relations between mutual funds and brokerage firms influence sell‐side analyst recommendations. Using a unique data set that discloses brokerage firms’ commission income derived from each mutual fund client as well as the share holdings of these mutual funds, we find that an analyst's recommendation on a stock relative to consensus is significantly higher if the stock is held by the mutual fund clients of the analyst's brokerage firm. The optimism in analyst recommendations increases with the weight of the stock in a mutual fund client's portfolio and the commission revenue generated from the mutual fund client. However, this favorable recommendation bias toward a client's existing portfolio stocks is mitigated if the stock in question is highly visible to other mutual fund investors. Abnormal stock returns are significantly greater both for the announcement period and, in the long run, for favorable stock recommendations from analysts not subject to client pressure than for equally favorable recommendations from business‐related analysts. In addition, we find that, subsequent to announcements of bad news from the covered firms, analysts are significantly less likely to downgrade a stock held by client mutual funds. Mutual funds increase their holdings in a stock that receives a favorable recommendation but this impact is significantly reduced if the recommendation comes from analysts subject to client pressure.     

Independents�� day? Analyst behavior surrounding the Global Settlement

In this paper, we examine the impact of NASD Rule 2711, NYSE Rule 472, and the Global Research Settlement on the recommendation performance of independent, affiliated, and unaffiliated analysts. We find that analysts from all three types of institutions issued fewer strong buys following these regulations designed to separate investment banking and equity research. Affiliated analysts were less likely to issue innovative recommendations. While downgrades became more prevalent following the regulations, they were significantly less informative. Independent research firms set up after the Global Research Settlement are of inferior quality; they issue more optimistic and less innovative recommendations that generate lower announcement period returns than independent firms existing prior to the Settlement. Our overall findings question whether investors will be better served via the shift in equity research to analysts at independent research firms.     

Measure for Measure: The Relation between Forecast Accuracy and Recommendation Profitability of Analysts

We examine the contemporaneous relation between earnings forecast accuracy and recommendation profitability to assess the effectiveness with which analysts translate forecasts into profitable recommendations. We find that, after controlling for expertise, more accurate analysts make more profitable recommendations, albeit only for firms with value‐relevant earnings. Next, we show that conflicts of interest from investment banking activities affect the relation between accuracy and profitability. In the case of buy recommendations, more accurate forecasts are associated with more profitable recommendations only for the nonconflicted analysts. For hold recommendations, higher levels of accuracy are associated with higher levels of profitability for conflicted analysts, provided these recommendations are treated as sells. Finally, we find that regulatory reforms aimed at mitigating analyst conflicts of interest appear to have improved the relation between accuracy and profitability. Specifically, the integrity of buy and hold recommendations has improved and the change is more pronounced for analysts expected to be most conflicted.     

What Drives Sell‐Side Analyst Compensation at High‐Status Investment Banks?

We use proprietary data from a major investment bank to investigate factors associated with analysts’ annual compensation. We find compensation to be positively related to “All‐Star” recognition, investment‐banking contributions, the size of analysts’ portfolios, and whether an analyst is identified as a top stock picker by the Wall Street Journal. We find no evidence that compensation is related to earnings forecast accuracy. But consistent with prior studies, we find analyst turnover to be related to forecast accuracy, suggesting that analyst forecasting incentives are primarily termination based. Additional analyses indicate that “All‐Star” recognition proxies for buy‐side client votes on analyst research quality used to allocate commissions across banks and analysts. Taken as a whole, our evidence is consistent with analyst compensation being designed to reward actions that increase brokerage and investment‐banking revenues. To assess the generality of our findings, we test the same relations using compensation data from a second high‐status bank and obtain similar results.     

Strategic distortions in analyst forecasts in the presence of short-term institutional investors

We document that analysts cater to short-term investors by issuing optimistic target prices. Catering dominates among analysts at brokers without an investment banking arm as they face lower reputational cost. The market does not see through the analyst catering activity and their forecasts lead to temporary stock overpricing that short-term institutional investors exploit to offload their holdings to retail traders. We also report evidence consistent with catering brokers being rewarded with more future trades channelled through them. Our study identifies a new source of conflicts of interest in analyst research originating from the ownership composition of a stock.     

The coverage assignments of financial analysts

Previous studies document that forecast accuracy impacts analyst career outcomes. This paper investigates the influence of forecast accuracy on coverage assignments. I show that brokerage houses reward accurate analysts by assigning them to high-profile firms and penalise analysts exhibiting poor accuracy by assigning them to smaller firms. The coverage of high-profile firms increases the potential for future compensation linked to investment banking and trading commissions. In addition, covering such firms increases analysts' recognition from buy-side investors, which, in turn, increases the likelihood of obtaining broker votes and votes for the Institutional Investor star ranking. Overall, my results indicate that high forecast accuracy leads to increased future compensation.     

Are small investors naive about incentives?

Security analysts tend to bias stock recommendations upward, particularly if they are affiliated with the underwriter. We analyze how investors account for such distortions. Using the NYSE Trades and Quotations database, we find that large traders adjust their trading response downward. While they exert buy pressure following strong buy recommendations, they display no reaction to buy recommendations and selling pressure following hold recommendations. This “discounting” is even more pronounced when the analyst is affiliated with the underwriter. Small traders, instead, follow recommendations literally. They exert positive pressure following both buy and strong buy recommendations and zero pressure following hold recommendations. We discuss possible explanations for the differences in trading response, including information costs and investor naiveté.     

Foreign Institutional Ownership and the Global Convergence of Financial Reporting Practices

This paper investigates whether foreign institutional investors affect the global convergence of financial reporting practices. Using several measures of reporting convergence, we show that U.S. institutional ownership is positively associated with subsequent changes in emerging market firms’ accounting comparability to their U.S. industry peers. We identify this association using an instrumental variable approach that exploits exogenous variation in U.S. institutional investment generated by the JGTRRA Act of 2003. Further, we provide evidence of a specific mechanism—the switch to a Big Four audit firm—through which U.S. institutional investors affect reporting convergence. Finally, we show that, for emerging market firms, an increase in comparability to U.S. firms is associated with an improvement in the properties of foreign analysts’ forecasts.